Central Bank: Boosting Confidence in Forex Market

June 18, 2009 by Prakash Dhawan
Filed under: Uncategorized 

The Central Bank is using a technique at its disposal to help build the reserves, protect exporters from a sharp rupee appreciation and allow banks to engage in speculative trading and make some gains. The Central Bank recently relaxed Net Trading Positions of commercial banks allowing more speculative trading in a move dealers said gave the foreign exchange market confidence about the position of the country’s foreign currency reserves.

“The limits on Net Trading Positions had been reduced by more than 2/3 last October when reserves started to fall because the Central Bank wanted to curb unnecessary speculation in the foreign exchange market but now the Central Bank seems to be comfortable with the position of the reserves and has increased limits allowing banks to engage in more speculative trading,” a dealer said. Simply put, the net trading position is a plus/minus limit imposed on a bank’s overnight foreign currency position. Last October, the Central Bank squeezed this limit which virtually prevented banks from actively engaging in speculative trading.

“The Central Bank did right by squeezing the limits because the reserves were precariously low. But now we see the Central Bank growing in confidence about building the reserves after the war, and this is the message we get when they increased limits on the Net Trading Positions,” a dealer said. However, the limits have not been increased to levels that banks had before the global economic crisis began to tell on Sri Lanka’s economy mid 2008 but dealers said the environment was fast improving.

Dealers said the rupee is being pressured in to appreciating against the dollar.  Last afternoon, the exchange rate stood at 114.9 with the Central Bank intervening to mop up the excess dollars so that the rupee is not appreciated further. Any kind of intervention is not appreciated in a market economy but the Central Bank is intervening partly to help exporters and partly to build-up reserves. If the rupee is allowed to appreciate on speculative trading, exports will become uncompetitive so the Central Bank is keeping the rupee stable at Rs. 114.9 against the dollar,” a dealer said.

“Reserves are down to US$ 830 million and the Central Bank obviously wants to boost its reserves. By keeping the exchange rate stable and by increasing the overnight foreign currency trading positions the Central Bank is hoping to boost its reserves because commercial banks will be more inclined to sell their dollars than to hold on to them.

“This is because banks are not willing to hold on to too many dollars with expectations of an appreciation with increased foreign currency inflows,” a dealer said as reported earlier this month. Also, commercial banks do not want to hold dollars because the yield is about 0.1 percent where as holding rupees could bring in a yield of about 13 percent,” he said. Central Bank governor was quoted in the media for saying the IMF standby facility was no longer urgent, with inflows expected to pick up based on positive sentiments created by the end of the war.

In May, the Central Bank had mopped up US$ 123 million from the market and the official reserves as end March stood at US$ 1.2 billion. Dealers said Central Bank intervention has created a market surplus in rupees of about Rs. 18 billion last afternoon.  The surplus liquidity situation in the market is also expected to help bring down lending rates, together with recent policy rate cuts of the Central Bank.  But a mixture of caution and contractual obligations on high interest paying deposits are making private commercial banks slow to respond with rate cuts. Dealers say it will happen within the next six months.

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